Heightened risk aversion has not dampened foreign investors' interest in SA markets

South African bonds and equities experienced the largest weekly foreign net inflows since April 2008 and October 2009 respectively in the week of the 2010 FIFA World Cup final.

Foreign investors were net buyers of South African bonds worth R11 billion and South African equities worth R2,7 billion for the week ending on 16 July 2010, says Dr Prieur du Plessis, Plexus group chairman and author of the Investments Postcards blog. “To put these figures into perspective, bonds have seen a net inflow from foreigners just short of R50 billion and equities just under R21 billion for the year to date,” says Du Plessis.

Foreign investors may have suddenly upped their inflows into local financial markets over the past week for several reasons, says Du Plessis.

“As far as the bond market is concerned, the Monetary Policy Committee is due to announce its decision regarding interest rates on Thursday, 22 July 2010, and foreigners may expect a rate cut. This will create the opportunity for a capital gain in the bond market.”

In terms of equities, there has been a relatively steady inflow from foreigners, with only seven of the 29 weeks for the year to date showing net outflows. “The reason for this could be that foreign investors continue to expect emerging markets to outperform slow-growing developed markets over the next year or two,” says Du Plessis.

He says it is important to watch foreigners’ actions in the South African market as they have an influence on the direction of asset prices and the exchange rate. “A Plexus study of the monthly correlations between foreign transactions and the FTSE/JSE All Share Index, the BESA All Bond Index and the rand/US dollar exchange rate since January 1999 shows they are all positive.”

“There is a good correlation between net foreign purchases of equities and the FTSE/JSE All Share Index. While the correlation between net foreign purchases of bonds and the All Bond Index is slightly lower, it is still positive. However, the strongest correlation can be found between the combined inflows into equities and bonds and the rand/dollar exchange rate,” says Du Plessis.

While many prophets of doom currently predict a global double-dip recession, Du Plessis believes most central banks, including the US Federal Reserve Board, are committed to keeping interest rates low, especially in light of the uncertainties regarding the fallout from the European debt.

Lending standards should thus remain loose in the coming months and, unless the European debt crisis worsens and austerity measures force some countries into depression, there could be a rebound in China’s economy towards the end of the third quarter. If this scenario materialises, the investment implications would include the following:

1. Mature-market bond yields have probably seen their best and are likely to rise.

2. The risk of investing in emerging-market bonds and equities is likely to decrease as global investors’ risk appetite increases.

3. Commodity stocks and especially metal stocks are likely to outperform.

4. Emerging-market currencies and the euro are likely to strengthen against the US dollar.

“While some caution is still warranted in the next month or two, equities, and especially emerging-market equities, remain Plexus’ preferred asset class in the longer term,” says Du Plessis. “Investors should not, however, bank on exceptional returns from equities as global growth could remain sub-par for quite a few years to come.”